{"id":7762,"date":"2023-05-12T09:15:38","date_gmt":"2023-05-12T13:15:38","guid":{"rendered":"https:\/\/ifintechworld.com\/markets\/why-the-sp-500-and-dow-industrials-differ-so-much-and-how-to-tweak-the-dow-to-your-liking\/"},"modified":"2023-05-12T09:15:39","modified_gmt":"2023-05-12T13:15:39","slug":"why-the-sp-500-and-dow-industrials-differ-so-much-and-how-to-tweak-the-dow-to-your-liking","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=7762","title":{"rendered":"Why the S&P 500 and Dow Industrials Differ So Much\u2014and How to Tweak the Dow to Your Liking"},"content":{"rendered":"

This is a commentary by Allan Sloan<\/strong>, an independent business journalist and seven-time winner of the Loeb Award, business journalism\u2019s highest honor.<\/em><\/p>\n

All of us who are investors know about the Dow Jones Industrial Average, whose daily up or down moves are usually the first number you hear or see in daily stock market reports.<\/p>\n

But even though the Dow has what is probably the greatest mindshare of any market metric, its financial market share is minuscule compared with the trillions of dollars indexed to the S&P 500 index, created more than 70 years after the Dow was.<\/p>\n

\n

The most recent official numbers from S&P Dow Jones Indices showed $7.1 trillion indexed to the S&P at year-end 2021 and just under $40 billion indexed to the Dow. An unofficial estimate based on subsequent market moves puts that at about $6.3 trillion indexed to the S&P and about $37 billion indexed to the Dow.<\/p>\n

Why is 170 times as much money tied to the S&P 500 as to the Dow? We\u2019ll look at some numbers that will tell us why.<\/p>\n

Along the way, we\u2019ll discuss the Dow divisor, which is used to adjust the Dow whenever one of its 30 components does a stock split or a spinoff, or when new companies are added to the Dow and old ones get tossed out.<\/p>\n

As a bonus, I\u2019ll show you how to create your own Dow by tweaking the divisor.<\/p>\n

Here we go.<\/p>\n

The Dow is an average based on the total share prices of its 30 components. By contrast, the S&P 500 is an index based on the market values of its 500 companies.<\/p>\n

When the Dow was created in 1885, before computers, the internet, and instantaneous communications, the only way to calculate a market indicator was to add up its components\u2019 share prices and divide by the number of components. So that\u2019s what Charles Dow did.<\/p>\n

However, by 1956, when the S&P 500 was launched, technology had advanced to the point that S&P could base its new market metric on companies\u2019 total stock market values rather than on their share prices.<\/p>\n

That\u2019s why the S&P 500 is a much better, much broader market indicator than the Dow. That, in turn, is why there\u2019s tons of money in S&P 500 index funds and only a relative pittance in Dow funds.<\/p>\n

For a classic example of why the S&P 500 is a much more popular investment vehicle than the Dow, let\u2019s look at two of the 30 Dow stocks:
\n Apple
\n (ticker: AAPL) and
\n UnitedHealth Group
\n (UNH).<\/p>\n

Apple, our country\u2019s most valuable stock, has a market value more than five times UnitedHealth\u2019s. But in the Dow, UnitedHealth\u2019s weight is almost three times Apple\u2019s.<\/p>\n

That\u2019s because UnitedHealth\u2019s share price (as of May 5, the date used for most of the numbers in this article) was $494.28 and Apple\u2019s was $173.57. As a result, UnitedHealth\u2019s weight in the Dow was 9.67% to Apple\u2019s 3.40%, according to Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices.<\/p>\n

However, when it comes to the S&P 500, according to numbers that I got from Silverblatt, Apple (No. 1 in market value) has more than five times the influence of UnitedHealth (No. 10): 7.47% to 1.34%.<\/p>\n

I asked Apple and UnitedHealth what they think about their spots on the Dow. Apple declined to weigh in. UnitedHealth didn\u2019t get back to me. <\/p>\n

Now, let me show you how to tinker with the Dow divisor, so that if you like, you can create your own Dow.<\/p>\n

Let\u2019s say that the management of UnitedHealth decided its stock would be more attractive to investors at about $250 rather than its current price of almost $500 and decided to split the stock 2-for-1.<\/p>\n

The split would have no impact on the S&P 500, because UnitedHealth\u2019s market value would be unchanged. But its weight in the Dow, according to Silverblatt, would drop to 5.06% from 9.67%. Meanwhile, the weight of the 29 other Dow components would rise to offset UnitedHealth\u2019s decline.<\/p>\n

Nothing financial will have changed, but the influence of individual stocks\u2014and the Dow\u2019s future numbers\u2014will have been modified.<\/p>\n

Now, to the Dow divisor. Dow Jones, which owns Barron\u2019s<\/em>, spun off its index business in 2010. It is now owned by S&P. When the Dow was created 138 years ago, it was calculated by taking the sum of its then-12 components and dividing by 12. But as time went on, the folks in charge adjusted their math to keep the Dow on an even keel through stock splits, spinoffs, and changes in components. <\/p>\n

That\u2019s done by using the Dow divisor, which is currently a wonderfully precise 0.15172752595384. Each $1 move in any Dow component moves the Dow by 1 divided by the divisor: roughly 6.59 points.<\/p>\n

If UnitedHealth were to split 2-for-1, the divisor would have to change to keep the post-split Dow consistent with the current Dow.<\/p>\n

You can use the methodology below to create your own Dow. Have UnitedHealth split 3-for-1 rather than my hypothetical 2-for-1. Add whatever stocks you like to the Dow, toss out the current Dow components that you\u2019d like to lose, calculate the new Dow divisor, and go on from there.<\/p>\n

To be sure, going through this exercise won\u2019t increase the value of your investment portfolio. But it makes you think, it can be fun, and it doesn\u2019t cost you any money. These days, that\u2019s a pretty good deal. <\/p>\n

Do Your Own Dow<\/h4>\n

Here is how I calculated what the new divisor would be if UnitedHealth had split 2-for-1 following the market\u2019s May 1 close. (I may be off a tiny bit because my calculator can handle only 10 digits and the divisor has 14, but you\u2019ll get the idea.)<\/p>\n